Contributions to Economics For further volumes: http://www.springer.com/series/1262 Giorgio Calcagnini l Ilario Favaretto Editors Small Businesses in the Aftermath of the Crisis International Analyses and Policies Editors Giorgio Calcagnini ` Universita di Urbino “Carlo Bo” Urbino Italy Ilario Favaretto ` Universita di Urbino “Carlo Bo” Urbino Italy ISSN 1431-1933 ISBN 978-3-7908-2851-1 ISBN 978-3-7908-2852-8 (eBook) DOI 10.1007/978-3-7908-2852-8 Springer Heidelberg New York Dordrecht London Library of Congress Control Number: 2012942853 # Springer-Verlag Berlin Heidelberg 2012 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed Exempted from this legal reservation are brief excerpts in connection with reviews or scholarly analysis or material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work Duplication of this publication or parts thereof is permitted only under the provisions of the Copyright Law of the Publisher’s location, in its current version, and permission for use must always be obtained from Springer Permissions for use may be obtained through RightsLink at the Copyright Clearance Center Violations are liable to prosecution under the respective Copyright Law The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made The publisher makes no warranty, express or implied, with respect to the material contained herein Printed on acid-free paper Physica-Verlag is a brand of Springer Springer is part of Springer-ScienceỵBusiness Media (www.springer.com) Preface SMEs are the backbone of the Italian entrepreneurial system and have provided the main impetus for economic development in the past decades Notwithstanding their structural weaknesses, SMEs remain the platform on which the Italian economy should build new growth processes Some SMEs should necessarily undertake strategies to increase their size and their degree of internationalization, to become the driving force behind the Italian production system; others should exploit their own areas of expertise within intelligent production chains that will be able to inherit what still remains of the industrial district logic on which the Italian economic development was based before the globalization process began It is imperative that all SMEs choose to re-position themselves in competitive terms, making up for time lost over the last decade The price of doing otherwise would be exclusion from all markets Supporting SMEs on their difficult path towards rebuilding is in the interest of the entire nation, and the role of banks in this context remains fundamental Banks are responsible for assuring adequate credit flows towards the firms that will be able to generate a new phase of investments as soon as they are capable; this is necessary to foster profound innovation in our production structure Investments aimed at incorporating growing amounts of new technologies in the production and management processes of SMEs are needed to fill the obvious productivity gap in their production factors with respect to larger firms But also investments to increase what we commonly call immaterial or intangible capital Factors such as human capital, social capital, the propensity to form networks, the ability to express one’s qualities and to adapt products to demand, etc., are not well managed by SMEs in terms of key strategy However, they appear to be fundamental elements so that the small size of these firms does not remain an insurmountable obstacle to their internationalization prospects The activities of conducting research and facilitating international dialogue which the University of Urbino has for some time – through the commitment and passion of Professors Calcagnini and Favaretto – dedicated to topics connected with SMEs thus represents a contribution of the highest order for entrepreneurs, their v vi Preface professional organizations, policy makers, and the banking system, in that it provides a growing and wide spectrum of elements on which to reflect and instruments with which to operate The call that rises from the various papers that make up this book concerns the urgency with which our country should necessarily, – without wasting time – make those entrepreneurial decisions and create those legal and infrastructural requirements to regenerate the system of small- and mediumsized firms The above-mentioned changes are necessary so that SMEs can compete and create adequate employment levels, thus making an incisive contribution to the growth of our economy Luciano Goffi Director-General of the Banca Popolare di Ancona, Jesi Introduction The economic crisis, though dramatic for many people, has represented an incredible opportunity for scholars studying different aspects of how modern economies function It has been a sort of “ideal” randomized experiment by which testing business models has further developed during recent years This book contains papers presented at the third international conference on ` small- and medium-sized businesses (SB) held at the Universita di Urbino “Carlo Bo” in October 2010 At that time we were excessively optimistic, given that the conference theme was how SBs responded to the crisis (and the state in which they found themselves in the aftermath of the crisis), thus assuming that the latter was mainly over by then If this were the case, we also expected to discuss new production and business models Unfortunately, as of this writing, the crisis is still affecting the world economy Many businesses found closing down a profitable option, while entrepreneurs who are still in business are working hard to adapt their companies to the new economic context Economies have different business structures around the world, and it is not our purpose here to analyze them in turn We will again refer to the Italian economy as a laboratory, given the large number of small-sized businesses that characterizes it The task of discovering differences across countries in the analyses contained in the chapters of this book is left to the reader One of the results that emerged from the two previous conferences (see Calcagnini and Favaretto, 2011) was that economies characterized by the presence of smallsized firms are more vulnerable to shocks than countries where the average size of businesses is larger There may be two main explanations behind the relationship between firm size and GDP growth rates In the case of Italy, they are strongly connected and concern, on one hand, the structure of the production system and, on the other, the competitive position of Italian firms in international markets Notwithstanding the restructuring carried out by Italian manufacturing firms during the period 2003–2007,1 at the outbreak of the current economic crisis the See de Nardis-Pappalardo (2010) vii viii Introduction Italian economy (industry) still found itself with a production system highly skewed towards small- and very small-sized businesses Being dependent upon small sized firms has two implications: (a) a large share of firms make their production decisions based on domestic demand; (b) small-sized firms find competing internationally more difficult than larger firms The combined effect of a compressed domestic demand and the increased competition in international markets may explain trends in Italian GDP growth rates during the crisis Moreover, by expanding the time horizon to a longer run scenario, this hypothesis can describe the entire period from the end of the 1990s onwards.2 Further, the economic crisis and its persistence caused the smallest and least efficient businesses to exit the market Simultaneously, many production chains dissolved, causing bankruptcies among sub-suppliers The latter exited the market because they lost most of their customers and not because they were inefficient In other words, the crisis negatively affected the labor division among most of Italian manufacturing firms, even though its effects had diversified intensities depending on the industry type, as well as the country in question Firms that positively reacted to the economic recession, and were still able to compete internationally followed two strategies On one hand, as an answer to the dissolving of production chains, firms reorganized their production cycle by reinternalizing some of the phases that had been previously outsourced or decentralized Consequently, the whole business organization has been restructured in the attempt to reach a higher level of efficiency in capacity utilization and economies of scale On the other, firms have been starting a new wave of product and process innovations that is positively affecting their cost structure This strategy was implemented by investing in intangible assets and also by hiring more skilled workers, even though mainly diffused among medium- and large-sized firms Both organizational and product innovations pay witness to the fact that the current reduction in the number of very small-sized firms still characterizing the Italian manufacturing industry is coherent with its need to further consolidate firms Therefore, it is likely that small-sized firms will play a less important role within a modern and competitive system conditioned by global markets This is so even though all subjects involved in market labor division (i.e., buyers and suppliers) should cooperate to favor firms reaching higher equity levels, investing larger amounts of resources in human capital, and developing a more modern finance culture among their managers and consultants If the former changes were made without a strongly coordinated and coherent industrial policy at the central and local levels, competing domestically and internationally will be increasingly difficult for Italian manufacturing businesses This brings us to the second explanation, still related to business size, which focuses on the internationalization process of the Italian economy By internationalization we mean trends in exports, imports, and foreign direct investment (FDI) It has been shown that internationalization is positively correlated to the number of See also Rey-Varaldo (2011) Introduction ix firms actually involved in international activities (i.e., the ‘extensive margin’) This ‘extensive margin’ is much more important than the ‘intensive margin’, that is the average exports, imports, and FDI per firm Therefore, successful internationalization is much more about increasing the number of firms involved than about, for example, increasing the involvement of firms already exporting Policy oriented to increase the ‘extensive margin’ should, therefore, improve firm performance in terms of employment and productivity.3 Further, firms that are larger in size have a more-skilled workforce, and are more innovative and productive Hence, they are more likely to export than others This pattern about the role of firm characteristics on the ‘extensive margin’ is very similar across countries Therefore, different industrial structures explain differences in countries’ international performances since similar firms behave similarly across countries.4 Recently, the Italian National Institute of Statistics (ISTAT) published new national accounts for the period 2000–2010 Changes between the old and new series occurred because of the adoption of the NACE-2007 industry classification and the CPA 2008 product classification associated with the industry classification In the case of exports and imports ISTAT calculated price indexes instead of the traditional unit, i.e average value indexes.5 The use of the new foreign trade price indexes to calculate exported and imported quantities shed new light on Italian external trade, especially on exports as an indicator of industry competitiveness The consolidated view according to which, during the 2000s, Italian industry experienced a decline with respect to the previous decades and other European countries does not find support in export growth rates (see Table 1) The latter were only negative and quantitatively larger than those of the other economies shown in Table during the most recent years of the economic crisis However, considering the whole period, the cumulated export growth rate is the same size as the French one Further, when the 2003–2007 period is analyzed, Italian export growth was significantly larger than that of France and Spain, but 40% lower than Germany’s (see Table 1) These were the years during which Italian industry underwent a restructuring that re-allocated resources from less to more efficient firms, from traditional consumption goods industries to ones with investment and intermediate goods This resource re-allocation involved industries showing both comparative advantages and disadvantages.6 In summary, Italian industry shows that at its core there is a significant group of firms that are trying to react to changes in their competitive environment and to the worst economic crisis since 1929 They aim to compensate for stagnant domestic demand by looking for new foreign markets or by expanding their existing ones However, the quest for growing foreign markets is a complex one because of the relatively small size of Italian businesses It would be ungenerous not to recognize See Mayer-Ottaviano (2007), pp 4–5 See Barba Navaretti et al (2010), pp and See ISTAT (2010) See de Nardis-Pappalardo (2010), p 4 x Introduction Table Cumulated export growth rates (quantities) 2000–2010 2000–2007 2003–2007 2007–2010 France 14.52 17.99 15.09 À3.47 Germany 55.37 52.60 39.43 2.78 Italy 14.77 22.87 24.35 À8.10 Spain 27.54 29.94 20.13 À2.40 Source: our calculations based on ISTAT (Italy) and IMF (France, Germany, Spain) data the effort made by those small firms that have internationalized, even though there are still too few of them Further, in most cases, internationalized small-sized firms face the challenge of foreign markets by means of traditional trade strategies and long distribution chains that provide thin profit margins Indeed, Italian manufacturing firms are traditionally successful in production, but less in marketing, in distribution chains, and in controlling final market outlets Therefore, they are able to retain only a small share of the whole product market value they generate.7 The challenge taken up by Italian industry needs to see a redoubling in firms’ efforts towards a more intensive use of scientific and technological knowledge, plus more skilled workers as well as increased equity among their financial resources This process should necessarily go along with an increase in firm size that does not mean that firms should become large-sized Firms with around 50 to 100 employees (medium-sized firms) contribute greatly to global exports and make up the backbone of export performance for most European countries.8 However, even among firms with 20 to 50 employees more than 60% are exporters This means that even among small-sized firms productivity is high enough to compensate for export costs.9 These results strongly support conclusions we reached in Calcagnini – Favaretto (2011) where we sketched a few simple policy guidelines in favor of the consolidation of Italian firms The latter will bring about an increase in firm size that, as shown above, is positively associated with higher levels of R&D investment, innovation, skilled employment, more effective foreign trade and FDI policies, and the opportunity to access financial resources coherently with all the decisions typical of modern companies These are a few issues that should be the primary concern of a modern industrial policy oriented to favoring the competiveness of Italian firms This without speaking of other regulation reforms focused on creating a more favorable environment for “doing business”.10 The contributions included in this book are ideally divided in two groups The first group focuses on the effects of the economic crisis on the ‘real side’ of small See Rey-Varaldo (2011), p 750 See Barba Navaretti et al (2010), p 9 See de Nardis-Pappalardo (2010), p 28 10 To understand the negative role played by Italian regulations on the start-up and development of firms, see World Bank (2011) Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms Table Summary statistics of the sample variables Variable Observations Mean Median SPD 917,721 3.17 2.81 RISK 917,721 0.03 COLL 917,721 0.59 0.81 PERS 917,721 0.46 DOUBLEG 917,721 0.29 LOAN_S 917,721 0.91 0.70 FIRM_S 917,721 0 LARGE 917,721 0.13 LEND_REL 917,721 0.57 NUM_REL 917,721 1.42 Source: Our calculations on Bank of Italy data SD 1.71 0.17 0.45 0.54 0.45 0.73 0.06 0.34 0.49 0.89 237 Min 0 0 0.04 0 Max 12.12 1 5.79 1 20 We assume that the conditional probability of the firm to post guarantees, Pr(GUAR ¼ 1|X), given a cumulative distribution function F (.), depends on loan, firm and bank characteristics Moreover, we add time dummies to capture the impact of the financial crisis Collateral and personal guarantees are jointly determined and depend on the same set of variables Therefore, the error correlation between the two types of guarantees may be different from zero, and we estimate the following bivariate probit model: À Á pij ¼ Pr GUARij;t ¼ 1jX ¼ FðX0 bÞ with X0 b ẳ b0 ỵ b1 RISKijt ỵ b2 LOAN Sijt þ b3 FIRM Sit þ b4 LEND RELijt þ b5 NUM RELit ỵ b6 BANK Sj ỵ b7 CENTRALi ỵ b8 SOUTHi ỵ b0 TIME Dt ỵ eijt (1) Variables used in model (1) are described in detail in the Data Appendix Table reports data summary statistics Columns (1) and (2) of Table report the marginal effects of the bivariate probit model (1), in which the likelihood ratio test rejects the null of zero correlation between the errors of the two probit models (see Table rho labeled LR test) Results support the hypothesis that guarantees are associated to riskier borrowers We capture customer risk by using a measure of observed risk (RISK) given by the “substandard” loan of the firm in temporary difficulties.6 In empirical literature the interest rate charged on the loan is often used as the measure of customer riskiness The use of an observed measure of customer riskiness such as RISK allows controlling for the endogeneity issue concerning guarantees 238 G Calcagnini et al Table The determinants of personal collateral and guarantees Bivariate probit marginal effects VARIABLES (1) Personal (2) Collateral (3) Personal (4) Collateral guarantees guarantees and large and large 0.054*** 0.014*** 0.050*** RISK 0.014*** (0.003) (0.003) (0.003) (0.003) 0.252*** À0.012*** 0.309*** LOAN_S À0.002*** (0.001) (0.001) (0.001) (0.001) FIRM_S À0.001 À0.458*** (0.008) (0.009) 0.038*** 0.060*** 0.030*** LEND_REL 0.059*** (0.001) (0.001) (0.001) (0.001) À0.153*** À0.003*** À0.154*** NUM_REL À0.004*** (0.001) (0.001) (0.001) (0.001) CENTRAL 0.019*** 0.081*** 0.021*** 0.072*** (0.001) (0.001) (0.001) (0.001) 0.188*** À0.124*** 0.174*** SOUTH À0.127*** (0.001) 0.001 (0.001) 0.001 À0.001 À0.026*** À0.008*** BANK_S À0.027*** (0.001) (0.001) (0.001) (0.001) 0.068*** À0.027*** 0.056*** 2007 À0.028*** (0.001) (0.001) (0.001) (0.001) 0.061*** À0.009*** 0.052*** 2008 À0.010*** (0.001) (0.001) (0.001) (0.001) 0.030*** 0.102*** 0.022*** 2009 0.102*** (0.001) (0.001) (0.001) (0.001) À0.216*** LARGE 0.030*** (0.002) (0.002) Observations 917,721 917,721 LR test 0.00 (p-value reported) 0.00 (p-value reported) rho ¼ AIC 2,234,231 2,227,902 BIC 2,234,501 2,228,171 Standard errors in parentheses *** p < 0.01, ** p < 0.05, * p < 0.1 The estimated coefficient of RISK is positive and statistically significant in both columns: riskier borrowers have a higher probability of posting collateral or personal guarantees While the impact of loan size (LOAN_S) on personal guarantees is negative but small in absolute values (column (1)), LOAN_S increases the probability of loans to be secured by collateral (column (2)): the result is likely to be driven by the presence of mortgages which, by the Italian code, have to be collateralized.7 The stronger bargaining power of large firms (FIRM_S, proxied by the loan size) with respect to firms of smaller size is captured by the negative marginal effect on the probability of posting collateral In our data we not have enough information to distinguish between different types of loans Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 239 Long-term lending relationships (LEND_REL) between banks and customers negatively affect the probability of posting both personal guarantees and collateral On the one hand, a long-term banking relationship may benefit the borrowers by helping to build trust between borrowers and lenders, and consequently to reduce moral hazard If guarantees are asked to solve moral hazard problems, the probability of posting guarantees decreases the longer the lending relationship (Boot and Thakor 1994) On the other hand, longer lending relationships could be associated with a higher use of collateral if long-term relationships generate more severe holdup problems (Ogawa et al 2010) The findings suggest that the negative effects of the hold-up problem dominate the benefits of the relationship lending Furthermore, increasing multiple lending relationships (NUM_REL) negatively affect the probability of posting both collateral and personal guarantees The result is consistent both with the hypothesis that “banks are unwilling to require a guarantee on their loans if this has the side effect of making implicitly available to competing lenders the result of their screening activity” (Pozzolo 2004, p 14) and with the fact that firms take actions against the monopoly power of a main bank, and eventually get better contract conditions, in the presence of multiple-bank relationships (Ogawa et al 2010) Customer regional location plays a significant role on the likelihood of posting both personal guarantees and collateral Compared to customers located in the North of Italy, loans provided by in Central Italy (CENTRAL) show a higher probability of posting guarantees or collateral Located in the South (SOUTH) show a positive marginal effect on collateral and a negative marginal effect on personal guarantees: this result is likely due to the riskiness of this type of guarantees in regions affected, among others, by high criminal rates The probability for firms to post personal guarantees is lower if banks are large (BANK_S ¼ 1) The finding is consistent with the theoretical and empirical literature according to which larger banks have a higher ability to evaluate customer risk and, therefore, screen riskier investment projects Particularly, secured loans may be considered by the lender as an alternative to screen and evaluate borrower or loan riskiness Smaller banks generally have a lower level of expertise and scarce resources to evaluate the economic loan risks Therefore, they have more incentives to use collateral instead of undertaking a project evaluation (Manove and Padilla ´ 1999; Manove et al 2001; Jimenez et al 2006) The economic and financial crisis increases the probability of loans to be secured, especially during the year 2009 To capture the impact of both large- and medium-sized firms on interest spreads, columns (3) and (4) of Table show the estimated coefficients of model (1) in which we use an alternative measure of firm size with respect to FIRM_S LARGE is again a dummy variable that takes value equal to one if the loan granted is greater or equal to 250,000 euro Producer households are normally of small size In the sample, 13.55% of loans are greater or equal to the 250,000 euro threshold while only less than 0.5% are greater or equal to 1,000,000 euro The estimates confirm previous findings that larger firms have a lower probability to post collateral In this case, however, the probability to post personal guarantees increases 240 4.2 G Calcagnini et al Guarantees and Loan Interest Rates: Multilevel Models The previous Section analyzed the determinants of collateral and personal guarantees, and results show that riskier borrowers have a higher probability of posting both collateral and personal guarantees as an incentive device to solve moral hazard problems This Section focuses on the impact of guarantees on loan interest rates Here, we assume that the bank loan interest rate is a positive function of: rij ẳ FrLị; markupij ; riskpremiumij (2) where rij is the interest rate charged to customer i by bank j,r(L) is the market interest rate, markupij is the mark-up over the market interest rate, and riskpremiumij captures loan and customer riskiness Here, r(L) is the overnight interest rate which is the same for all banks The mark-up term captures banks’ market power We assume that the mark-up varies across customers inversely with the customer size (FIRM_S) and directly with the bank size (BANK_S) Moreover, the number of bank relationships (NUM_REL) and the time length (number of years) of the lending relationship (LEND_REL) may also affect the mark-up While we expect a negative impact for NUM_REL, the impact of the length of the lending relationship is not known a priori On one side, a longer lending relationship should increase loan interest rates by generating an information monopoly that enables banks to extract rents from borrowers On the other, a long-term banking relationship may benefit the borrowers: borrowers pay higher interest rates and pledge guarantees early in the relationship, but, once their first project is successful, they are awarded with unsecured loans and lower loan rates (Boot and Thakor 1994) The risk premium is the interest rate component that positively depends on customer and loan riskiness We capture customer risk by means of a measure of observed risk, RISK, as described in Sect 4.1 Loan riskiness depends positively on loan size (LOAN_S) It is possible that LOAN_S may capture firm size If this were the case the estimated coefficient of this variable may have negative sign Moreover, we make use of additional information on the presence of guarantees to control for customers’ risk Specifically, we use the relative (to the loan size) amount of collateral (COLL) and personal guarantees (PERS) posted, and a dummy (DOUBLEG) to capture the contemporaneous presence of both types of guarantees However, as described in Sect 2, the impact of guarantees on interest rate is not defined a priori Indeed, guarantees may be used as a signal of high quality debtor, and therefore we should expect a negative impact on interest rate; or riskier borrowers may post guarantees, and therefore we should expect a positive impact of guarantees on interest rate Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 241 Finally, we control for customers’ geographical location by means of three dummy variables (NORTH, CENTRAL and SOUTH).8 Since r(L) and rij are highly correlated, we opted for a slightly different version of model (2) where the dependent variable is the spread between the two interest rates (SPDi,j, ¼ rijÀr(L)) As explanatory variables we have three main groups of variates: – A vector Xi,j,t containing the characteristics of each loan contract: COLL, PERS, DOUBLEG and LOAN_S; – A vector Fi,t containing firm characteristics: RISK, NUM_REL, LEND_REL, FIRM_S, CENTRAL and SOUTH – A vector Bj,t containing bank characteristics: BANK_S Furthermore, our model includes time-dummy variables to identify the impact of the economic crisis and two interaction variables that are expected to capture the impact of the financial crisis on collateral and personal guarantee requirements CRISIS*COLL and CRISIS*PERS, respectively The empirical equation takes the following form: SPDi;j;t ẳ b0 ỵ b10 Xi;j;t ỵ b20 Fi;t ỵ b30 Bj;t ỵ b40 TIME Dt ỵ b5 CRISIS COLLi;j;t ỵ b6 CRISIS PERSi;j;t ỵ ui;j;t (3) The subscript i refers to firms, j to banks, t to time periods ui,j,t is a disturbance with a multiway error-components structure: ui;j;t ẳ ỵ li;j ỵ ei;j;t where ai, li,j and ei,j,t are assumed to be i.i.d., and are mutually independent Antweiler (2001) derived the maximum likelihood estimator for panel data with unbalanced hierarchies We deal with a single-nested panel in which firms may be grouped by banks, and estimate a “mixed effects” model in which a fixed-effects approach is used to estimate regression coefficients and a random-effects approach is used for the low-level group, i.e banks To determine if our interest rate model can be correctly identified as a supply function, we should assume that the variance of the stochastic term in the loan offer function is smaller than the corresponding variance in the loan asking function This assumption seems acceptable given that, for instance, a given bank forces its lending officers to follow certain common techniques of credit analysis that may result in more precision in processing lending application (i.e in a lower stochastic variance) Diversely, borrowers are subjected to industry specific seasonal and cyclical shocks; moreover, firm treasurers are not compelled to behave similarly when they apply for loans Both reasons imply a larger stochastic variance for the loan asking function (see Hester (1967), p 132) 242 G Calcagnini et al Fig Nested panel data model The multilevel analysis assumes that the latent variables, or random effects, can be interpreted as unobserved heterogeneity at the different levels inducing dependence among all lower-level units in the same higher-level unit Whereas random intercepts represent heterogeneity between clusters in the overall response, random coefficients represent heterogeneity in the relationship between the response and explanatory variables (Rabe-Hesketh et al 2004) Figure represents the data structure We have information on bank loans granted to firms Each bank grants loans to many firms The paper estimates model (3) parameters both under the assumption that the intercept is random and the overall response varies across banks; and under the assumption that the slope is also random, i.e the impact of guarantees and collateral on the loan interest rate varies across banks Moreover, we allow for correlation among random effects by assuming an unstructured variancecovariance matrix In the dataset some firms may have multiple bank relationships in each year (Firm in Fig 1).9 Table shows the estimated coefficients of the multilevel models The likelihood ratio test rejects the null of no random effects for all specifications (see Table re labeled LR test, p-value reported) Different model specifications are shown in Table First, we estimated model (3) both under the assumption that the intercept is random, and under the assumption that the slope is also random, i.e the impact of guarantees and collateral on the loan interest rate varies across banks Testing the two specifications by means of the Akaike Information Criterion (AIC) and the Bayesian Information Criterion (BIC), according to which “small is better”, the latter specification is preferred to the former Therefore, column (1) of Table shows the estimated coefficients of the The panel data is not a pure nested model, as we have some firms that have loans from different banks in each period Therefore, for robustness checks purposes, we estimate model (3) considering only firms that not have multiple bank relationships (NUM_REL ¼ 1) in each year Estimates confirm the findings of Tables Table The determinants of bank loan interest rates (SPD) Multilevel models (3) Guarantees and (1) Baseline model (2) Guarantees and crisis interaction risk interaction RISK 0.661*** 0.659*** 1.273*** (0.008) (0.008) (0.016) À1.208*** À1.186*** COLL À1.182*** (0.045) (0.045) (0.046) PERS À0.018* 0.013 0.017 (0.010) (0.010) (0.010) 0.167*** 0.167*** DOUBLE_G 0.172*** (0.005) (0.005) (0.005) LOAN_S À0.150*** À0.149*** À0.151*** (0.002) (0.002) (0.002) 0.065*** 0.066*** LEND_REL 0.063*** (0.003) (0.003) (0.003) 0.057*** 0.059*** NUM_REL 0.058*** (0.002) (0.002) (0.002) 0.050** 0.054** FIRM_S 0.053** (0.022) (0.022) (0.022) BANK_S À0.012 À0.008 À0.009 (0.056) (0.056) (0.056) 0.052*** 0.051*** CENTRAL 0.053*** (0.006) (0.006) (0.006) 0.132*** 0.129*** SOUTH 0.130*** (0.004) (0.004) (0.004) 0.232*** 0.232*** 2007 0.231*** (0.004) (0.004) (0.004) 1.247*** 1.240*** 2008 1.257*** (0.004) (0.006) (0.006) 2009 1.867*** 1.865*** 1.856*** (0.004) (0.006) (0.006) À0.007 (0.056) 0.051*** (0.006) 0.129*** (0.004) 0.233*** (0.004) 1.250*** (0.006) 1.867*** (0.006) À1.213*** (0.045) 0.010 (0.010) 0.170*** (0.005) À0.111*** (0.003) 0.065*** (0.003) 0.058*** (0.002) (4) Alternative firm size “Large” 0.061*** (0.004) À0.156*** (0.002) 0.071*** (0.003) 0.073*** (0.002) 0.062** (0.026) 0.043 (0.106) 0.044*** (0.006) 0.102*** (0.005) 0.233*** (0.004) 1.259*** (0.004) 1.878*** (0.005) (continued) 0.624*** (0.009) (5) IV multilevel model Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 243 (1) Baseline model (2) Guarantees and crisis interaction 0.061*** (0.006) À0.060*** (0.005) Constant 2.961*** 2.960*** (0.047) (0.047) Observations 917,721 917,721 LR test re ¼ 0.00 0.00 AIC 3,107,039 3,106,808 BIC 3,107,297 3,107,090 Num of banks 197 197 Standard errors in parentheses *** p < 0.01, ** p < 0.05, * p < 0.1 IVPERS IVCOLL LARGE RISK*PERS RISK*COLL CRISIS*PERS CRISIS*COLL Table (continued) 2.947*** (0.047) 917,721 0.00 3,104,643 3,104,948 197 (3) Guarantees and risk interaction 0.073*** (0.006) À0.057*** (0.005) À0.873*** (0.019) À0.104*** (0.014) 2.942*** (0.047) 917,721 0.00 3,106,526 3,106,807 197 À0.105*** (0.006) (4) Alternative firm size “Large” 0.063*** (0.006) À0.060*** (0.005) À0.962*** (0.077) 0.008 (0.021) 2.857*** (0.063) 917,721 0.00 3,194,662 3,194,920 197 (5) IV multilevel model 244 G Calcagnini et al Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 245 multilevel model (3) with random intercept and random slope, but without the interaction variables CRISIS*PERS and CRISIS*COLL Results show that the presence of collateral (COLL) decreases the interest rate, while the presence of personal guarantees (PERS) is statistically significant only at 10% level These findings are consistent with the idea that once banks control for the borrower risk, collateral decreases interest rates Moreover, producer households, being of small size, suffer from informational opacity more than larger firms, and collateral might act as a positive signalling device (Berger and Udell 1998) However, the estimated coefficient of DOUBLEG is positive and statistically significant: it is likely that riskier borrowers are requested to post both types of guarantees Loan size (LOAN_S) and interest rates show an inverse relationship In this case the scale effect of the loan size more than counterbalances the potentially higher risk associated to loans of larger size As for firm characteristics, the longer the lending relationship (LEND_REL) is, the higher the interest rate The finding is not new to the empirical literature (see Harhoff et al 1998; Petersen and Rajan 1994 for a survey of the empirical literature) Chakravarty and Yilmazer (2009) assert that the overall granting process is a sequential process which unfolds in three stages: application, decision and rate setting The authors find that the lending relationship matters only in the first and second stages, i.e.: conditional on being approved, relationships are not important in determining the loan rate Similarly, Petersen and Rajan (1994) not find statistical evidence that the strength of the lender-borrower relationship is correlated with cheaper credit Moreover, our dataset contains different types of loans for which reputation and relationship effects may be less important (Berger and Udell 1995) Therefore, the length of the lending relationship may capture not only the strength of the bank-borrower relationship, but also a monopoly power of a main bank that asks for higher interest rates The ex-ante (or observed) firm riskiness is captured by the variable RISK whose estimated coefficient, as expected, is positive and statistically significant Furthermore, the number of lending relationships (NUM_REL), which may be also interpreted as a measure of borrower riskiness, increases interest rates As for firm size, our results show that the former has a positive influence on interest rates, but this result may be due to the way the FIRM_S variable was constructed Indeed, FIRM_S is a binary dummy variable which takes a value of when the loan value is equal or greater €1,000,000 and when the loan value is less than €1,000,000.10 Producer households are normally of small size; therefore this variable might capture the higher risk associated to larger loans Furthermore, firm size may be more efficiently captured by the LOAN_S Customers located in the Centre and the South of Italy are charged a higher interest rate than customers in the North Finally, time dummies account for the 10 This threshold is used in the statistics of European Central Bank and in several Bank of Italy papers 246 G Calcagnini et al effects of the financial crisis on interest rates Their coefficients are highly statistically significant and positive reflecting the increase in interest rates between 2006 and 2009 To account for the potential interaction of the crisis with the presence of collateral and guarantees, column (2) of Table shows the estimated coefficients of model (3) Overall, estimates shown in column (2) confirm the findings of column (1) Specifically, the estimates show that loans secured by personal guarantees pay a lower interest rate only during the crisis, as the coefficients of PERS is not statistically significant and the coefficient of CRISIS*PERS is negative and statistically significant at 1% level The result, together with the negative estimated coefficients of collateral (COLL) show that collateral and guarantees contribute both to reducing loan interest rates and avoiding credit rationing (as shown by descriptive statistics in Tables and 4) All model specifications find that riskier firms pay higher interest rates Column (3) shows the estimated coefficients of model (3) in which we further control for the impact of the interaction of firm risk with guarantees on loan interest rates by adding two interaction variables RISK*COLL and RISK*PERS Estimates show that the negative impact of guarantees on loan interest rates is higher the riskier the firm: ceteris paribus, guarantees are a more powerful instrument for ex-ante riskier borrowers than for safer borrowers Indeed, riskier borrowers obtain significantly lower interest rates on secured loans than the interest rate they would be charged on unsecured loans To capture the impact of both large- and medium-sized firms on the interest spreads, column (4) shows the estimated coefficients of model (3) in which the variable LARGE is used instead of the variable FIRM_S to measure firm size The estimated coefficient shows that medium- and large-sized firms pay lower interest rates than smaller firms Overall, the estimates confirm findings in columns (1)–(3) of Table To check the robustness of our results column (5) in Table shows the estimated coefficients of the baseline model specification of column (1) when treating collateral and personal guarantees as endogenous variables Guarantees might be endogenous due to unmeasured and unmeasurable influences acting at firm or bank levels such as the fact that interest rates and guarantees are simultaneously set at the time of a loan approval 11 In multilevel analysis, the unmeasured influences of omitted variables or measurement error in the fixed part gets incorporated in the random part of the model, thereby violating the assumption of the independence of regressors and model disturbances (Ebbes et al 2004) If this is the case, the OLS estimated coefficients are biased, and instrumental variables (IV) estimation techniques can be used to reduce the bias (Spencer and Fielding 2000) 11 All bank level variables in model (3) are exogenous Therefore, we rule out bank-level endogeneity and only take into account firm level endogeneity Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 247 Table Random-effects parameters SPD Coef Std Err z P > z [95% Conf Interval] Standard dev (COLL) Standard dev (PERS) Standard dev (CONSTANT) Covariance (COLL, PERS) Covariance (COLL, CONSTANT) Covariance (PERS, CONSTANT) Standard dev (RESIDUAL) 0.034 0.008 0.034 0.092 0.014 0.096 0.001 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.613 0.116 0.633 0.965 0.173 1.007 1.313 18.18 15.01 18.44 10.52 12.53 10.45 1,354.34 0.547 0.101 0.566 0.785 0.146 0.818 1.312 0.679 0.132 0.700 1.145 0.201 1.196 1.315 First of all, to obtain IV estimates of model (3), we used Lewbel’s approach to construct ‘internal instruments’ (Lewbel 1997) and then estimated separate multilevel models for COLL and PERS as function of the instruments and all the other exogenous variables included in the model Secondly, we used the predictions of the endogenous variables, IVCOLL and IVPERS, as variables in model (3) to obtain consistent estimates of the fixed-effects parameters Then, we corrected the coefficients’ variance-covariance matrix by means of the ‘real’ mean square error (Baltagi 2002).12 IV estimates confirm the previous finding: collateral decreases interest rates, while personal guarantees have no statistically significant effect on interest rates This finding is consistent with the fact that personal guarantees are external to the firm and are typically posted by the proprietorship In the case of producer households, the owners are requested by law to post their personal wealth in case of default and, therefore, the result that the estimated coefficient of personal guarantees is not statistically significant is not surprising.13 Moreover, even if personal guarantees are external (and therefore should be more powerful in solving adverse selection or moral hazard problems), they are potentially riskier than collateral as they represent a generic claim on the wealth of the grantor, who has therefore a large degree of freedom and could possibly default on it Table shows the fixed-effects estimates of model (3) As for guarantees, fixed effects refer to the overall expected effect of the presence of real or personal guarantees on interest rates However, according to our model specification, random effects also depend on guarantees Random effects measure whether the impact of guarantees on interest rates differs among banks/from bank to bank Table shows the estimated random-effects parameters of model specification shown in column (1) of Table The variance component of the random intercept (Standard dev (CONSTANT)) is statistically significant, meaning that interest rates significantly differ across banks Furthermore, the slopes of collateral and personal guarantees also show statically significant variance components, (Standard dev 12 The latter is constructed by taking into account the best linear unbiased prediction of the random part of the baseline model 13 The result is consistent with previous studies according to which partnerships have a lower probability of posting personal guarantees than limited liabilities firms (Bonaccorsi di Patti 2006) 248 G Calcagnini et al (COLL)) and (Standard dev(PERS)), respectively Therefore, real guarantees and personal guarantees affect loan interest rates through random effects that differ across banks All variance components can be used to partition the variance across levels and compute the intra-class correlation coefficient (ICC) of interest rates within a cluster (bank) Specifically, the intra-class correlation coefficient is the proportion of the interest rate total variance that is attributed to the bank level, and it is equal to: ICC ẳ 0:6332 ỵ 0:1162 ỵ 0:6132 ẳ 0:31; 0:6332 ỵ 0:1162 ỵ 0:6132 ỵ 1:3132 meaning that the 31% of the interest rate total variance is attributable to bank-level differences (Albright and Marinova 2010) Finally, the correlations between bank intercepts and slopes (Covariance (COLL, CONSTANT)) and (Covariance (PERS, CONSTANT)) are positive and statistically significant across banks Therefore, given the negative estimated coefficient of collateral (see Table 8), the decrease in interest rates for a 1% increase in guarantees is larger for banks charging higher average interest rates Conclusions This paper analyzed the role of guarantees on loan interest rates charged on producer households’ loans In addition, it tried to understand bank behavior before and during the recent financial crisis The analysis focused on small businesses since informational opacity is expected to be negatively correlated with firm size Therefore, small-sized firms are more often affected by either credit rationing and/ or higher interest rates than larger firms These two phenomena typically exacerbate during financial crises During the period 2008–2009, the number of loans to small businesses decreased by more than 30% as opposed to a 20% decrease in the case of all firms (firms and producer households) The bivariate probit analysis showed that the probability of loans to be secured increased during the recent financial crises Moreover, the probability of loans to be secured by collateral or personal guarantees increases with firm riskiness Estimates from our interest rate model showed that loan interest rates respond differently to collateral and personal guarantees Collateral helps reduce loan interest rates charged to small-sized businesses, once we control for borrower and loan riskiness, before and during the financial crisis As for personal guarantees, our findings showed a positive (a decrease) effect on interest rates only during the financial crisis Indeed, in normal times, personal guarantees not give the lender a specific claim on particular assets, and restrict the actions (s)he could take in case of borrowers’ bankruptcy Therefore, they have no effect on loan interest rates Guarantees and Bank Loan Interest Rates in Italian Small-Sized Firms 249 During troublesome periods, such as the current financial crisis, providing personal guarantees together with collateral is a signal of borrowers’ quality that has positive effects on interest rates Finally, results showed that – ceteris paribus – guarantees are a more powerful instrument for ex-ante riskier borrowers than for safer borrowers Indeed, riskier borrowers obtain significantly lower interest rates on secured loans than interest rate they would be charged on unsecured loans Data Appendix SPD is the spread between the interest rate applied on loan by each bank and the interest rate on overnight interbank deposits Both interest rates are averages of each year’s fourth quarter values COLL is the share of each loan guaranteed by collateral Loans are mainly mortgages granted by banks to the borrower This variable is a proxy for inside collateral PERS is the share of each loan guaranteed by personal guarantees Personal guarantees are granted by third parties in favour of borrowers This variable acts as outside collateral DOUBLEG is a binary dummy variable that takes a value of when both personal and real guarantees are posted and otherwise LOAN_S is the ratio between the amount of loan granted to the firm by each bank in the database and the average size of loan granted to firms of the same sector It represents a proxy for loan size FIRM_S is a binary dummy variable which takes a value of when the amount of loan is equal or greater €1,000,000 and when the value of loan is less than €1,000,000 Alternatively, we use the dummy variable LARGE The latter is a binary dummy variable which takes a value of when the amount of loan is equal or greater € 250,000 and when the value of loan is less than € 250,000 RISK is a dummy variable that takes value equal to one if the firm has substandard loans, i.e the firm is in temporary difficulty This variable is a measure of ex ante (observed) credit risk of the firm LEND_REL is a binary dummy variable that takes a value of in the case of a firm-bank relationship three or more years long and a value of in the other cases NUM_REL is the number of lending relationships for each firm in each year CENTRAL is a binary geographical dummy variable that has a value of for customers with headquarter in Central Italy and otherwise SOUTH is a binary geographical dummy variable that has a value of for customers with headquarter in Southern Italy and otherwise BANK_S is a binary dummy variable that has a value of for banks which are classified as “major” or “large” according to the classification of Bank of Italy (2008) 250 G Calcagnini et al CRISIS*COLL represents the interaction between collateral (COLL) and a dummy that is equal to1 in every year of the financial crisis period (2008–2009); it is in the pre-crisis years (2006 and 2007) CRISIS*PERS represents the interaction between personal guarantees (PERS) and a dummy that is equal 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Springer-Verlag Berlin Heidelberg... (2011) Doing business 2012: doing business in a more transparent world http://www doingbusiness.org/reports/global-reports/doing -business- 2012 Contents SME and Entrepreneurship Policies After the